AS ITS POPULARITY

has grown, the exchange-traded-fund industry has flooded the market with products that cover almost every aspect of the investing world. On average, a new fund launched for each workday last year. But none of those ETFs are more important to the burgeoning industry's future reputation than the four that are expected to start trading hands soon.

Last Friday, the Securities & Exchange Commission filed a notice that appeared to clear the way for a quartet of "actively managed" ETFs from PowerShares. (They are now waiting for a short public comment period to end later this month.) It's big news for PowerShares, which filed a preliminary prospectus with the agency last November. The approval could also signal that similar offerings from Vanguard, Bear Stearns and iShares are close to getting the green light, too.

The emergence of actively managed ETFs would push the boundaries of the $600 billion ETF industry, which was initially forged on the back of simple index fund-like products. The concept combines the low costs and trading flexibility of an ETF with the stock-picking savvy of a fund manager. To many prospective investors, it's the best of both worlds. And should these ETFs be successful, they could potentially take a much bigger chunk out of the $12 trillion that's invested in traditional funds.

"The ETF industry has been talking about this for years," says J.D. Steinhilber, president of Agile Investments, a money-management firm that specializes in ETF portfolios. "This is a big deal."

ETFs and mutual funds have long had their share of loyalists. Some financial pros favor ETFs because they trade throughout the day, a distinct advantage when they are trying to get in and out of tricky markets. ETFs also tend to be more tax efficient and charge cheaper fees than the average mutual fund. However, investors who favor mutual funds point to the experienced fund managers who beat their benchmarks every year. This group is willing to pay higher fees and capital gains in return for the opportunity to reap those big gains.

Both camps make some good arguments. The goal of actively managed funds is try to take the best attributes of ETFs and mutual funds and marry them. But while the concept looks great on paper, getting these ETFs to actually work is another thing altogether.

The biggest hurdle is transparency. Fund managers are reluctant to reveal what they're buying for fear speculators will front-run their trades, a tactic that can artificially boost the prices of their best ideas. ETFs, though, have to be transparent because they trade throughout the day. Market makers must constantly know what's in their portfolios in order to match buyers with sellers.

So the question is just how much transparency can actively managed ETFs afford? Fund companies have gotten around this debate by using computer formulas that don't involve manager egos or stick to an area of the investing world that is somewhat immune to front-running. Such tactics could serve as one possible solution to the transparency issue, but it will nevertheless be an ongoing problem.

Vanguard has filed for four fixed income actively managed ETFs that are just additional share classes of the company's Inflation-Protected Securities, Short-Term U.S. Treasury, Intermediate-Term U.S. Treasury, and Vanguard Long-Term U.S. Treasury funds. This strategy has worked well for the company. It relieves them of spending big bucks on creating and launching a whole new fund and it gives investors an instant performance track record a luxury most competitors can't offer. There's "no word" yet on whether SEC approval is imminent, according to a Vanguard spokesperson.

Bear Stearns' ETF, called Current Yield and sporting the tentative ticker YYY, will move between a series of fixed-income products, including short-term and municipal bonds, corporate debt and asset-backed securities, according to its prospectus. The ETFs proposed by iShares will focus on currencies that allow investors to place bets based on the strength of the dollar.

However, it's PowerShares' actively managed ETFs that are garnering the most attention. Two of the funds Active AlphaQ and Alpha Active Multi Cap will be subadvised by Alpha Equity Research, or AER, a well-regarded financial research firm based in North Hampton, N.H. The other two, called Active Mega-Cap and Active Low Duration, will be run by a unit of Invesco, PowerShares' parent company.

The Active AlphaQ fund will start with a universe of 3,000 companies that have market capitalizations over $400 million. AER will narrow the list by using its proprietary "NOW" ranking system, which takes into account a stock's trading volume, earnings estimates and valuation, among other criteria. AER keeps a master list of 100 of the best picks and the fund will own the largest 50 of them. (Those stocks will probably trade on the Nasdaq.) Most importantly, the fund plans to solve the transparency issue by rebalancing its portfolio at the close of every week. The multicap fund will follow a similar procedure.

The Active Mega-Cap ETF will also use a quantitative formula to do its stock picking. It appears, though, that the managers of this fund will have much more freedom to re-jigger the portfolio when they feel it's warranted. They will favor stocks with above-average growth prospects and will "attempt to overweight securities with positive characteristics identified in the evaluation process and underweight securities with negative characteristics," according to the prospectus. (The portfolio will be updated daily.) The issue of front-running tends not to be an issue with megacap stocks since they're widely owned and experience heavy trading each session. Megacap stocks are also one of the hardest niches for a manager to add value to, so if this fund can even squeak out an extra percentage point above the returns of the S&P 500 it will be considered a success. Finally, the Active Low Duration ETF will invest in a basket of fixed-income investments.

It's inevitable that these funds will hit the market. What isn't a slam dunk is whether investors will be willing to put money into them. "I'm taking a wait-and-see attitude," says Tom Lydon, president of Global Trends Investments and editor of ETF Trends newsletter. "I don't think is one of those cases where if they build it people will come."

The primary concern: Most fund companies haven't revealed how much they will charge for these ETFs. "There are still some important questions to answer, like how much they are going to cost," says Sonya Morris, a mutual fund analyst at Morningstar. "That will be a big factor."

Ultimately, though, time will be the deciding factor as investors wait for these funds to prove in the real world what they have long promised to do on paper.